Is the Inventory Story at DENTSPLY International Making You Look Clever?

Here at The Motley Fool, I've long cautioned investors to keep a close eye on inventory levels. It's a part of my standard diligence when searching for the market's best stocks. I think a quarterly checkup can help you spot potential problems. For many companies, products that sit on the shelves too long can become big trouble. Stale inventory may be sold for lower prices, hurting profitability. In extreme cases, it may be written off completely and sent to the shredder.

Basic guidelines
In this series, I examine inventory using a simple rule of thumb: Inventory increases ought to roughly parallel revenue increases. If inventory bloats more quickly than sales grow, this might be a sign that expected sales haven't materialized. Is the current inventory situation at DENTSPLY International (Nasdaq: XRAY  ) out of line? To figure that out, start by comparing the company's inventory growth to sales growth. How is DENTSPLY International doing by this quick checkup? At first glance, pretty well. Trailing-12-month revenue increased 23.9%, and inventory increased 19.6%. Comparing the latest quarter to the prior-year quarter, the story looks decent. Revenue expanded 25.2%, and inventory improved 19.6%. Over the sequential quarterly period, the trend looks healthy. Revenue grew 6.5%, and inventory was flat.

Advanced inventory
I don't stop my checkup there, because the type of inventory can matter even more than the overall quantity. There's even one type of inventory bulge we sometimes like to see. You can check for it by examining the quarterly filings to evaluate the different kinds of inventory: raw materials, work-in-progress inventory, and finished goods. (Some companies report the first two types as a single category.)

A company ramping up for increased demand may increase raw materials and work-in-progress inventory at a faster rate when it expects robust future growth. As such, we might consider oversized growth in those categories to offer a clue to a brighter future, and a clue that most other investors will miss. We call it "positive inventory divergence."

On the other hand, if we see a big increase in finished goods, that often means product isn't moving as well as expected, and it's time to hunker down with the filings and conference calls to find out why.

What's going on with the inventory at DENTSPLY International? I chart the details below for both quarterly and 12-month periods.

Source: S&P Capital IQ. Data is current as of latest fully reported quarter. Dollar amounts in millions. FY = fiscal year. TTM = trailing 12 months.

Source: S&P Capital IQ. Data is current as of latest fully reported quarter. Dollar amounts in millions. FQ = fiscal quarter.

Let's dig into the inventory specifics. On a trailing-12-month basis, finished goods inventory was the fastest-growing segment, up 24.0%. On a sequential-quarter basis, finished goods inventory was also the fastest-growing segment, up 3.1%. DENTSPLY International seems to be handling inventory well enough, but the individual segments don't provide a clear signal.

Foolish bottom line
When you're doing your research, remember that aggregate numbers such as inventory balances often mask situations that are more complex than they appear. Even the detailed numbers don't give us the final word. When in doubt, listen to the conference call, or contact investor relations. What at first looks like a problem may actually signal a stock that will provide the market's best returns. And what might look hunky-dory at first glance could actually be warning you to cut your losses before the rest of the Street wises up.

I run these quick inventory checks every quarter. To stay on top of inventory and other tell-tale metrics at your favorite companies, add them to your free watchlist, and we'll deliver our latest coverage right to your inbox.

Seth Jayson had no position in any company mentioned here at the time of publication. You can view his stock holdings here. He is co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 14, 2012, at 2:26 PM, rongone wrote:

    Seth, your analysis has a lot of math and information fed by formulas, but lacks the feet on the ground understanding of Dentsply. Dentsply's inventory has increased over the past year for 3 specific reasons: 1) Management's inability to implement a Sales and Operations Planning Procedure to forecast customer demand and integrate that information into a viable production plan that would match that demand with saleable finished goods.

    2) Due to lacking the implementation of a proper S&OP, customer demand prognostication is left to Sales and Marketing executives, who produce inordinately rosey projected sales figures that have no relation to actual sales. This causes a building of unwanted inventory, while dissatisfied customers go elsewhere to secure the inventory they really want.

    3) In order to mitigate the effect of ever growing SG&A expenses on quarterly earnings calls, executive management tries to point to increased operational efficiencies (listen to Chris Clark during the 2nd Qtr. 2012 call). Translating this corporatespeak tells us that production facilities are producing finished goods (causing resupply of raw and purchased inventory) in order to eat up overhead costs. The result of this production may or may not satisfy actual customer demand. The unwanted product reamains in inventory until sold, or exceeds its self life.

    These are the reasons that inventory--raw, purchased, and finished goods--continue to grow at Dentsply.

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